Is it always true that debt means trouble for your finances?
This is one of the questions you could ask yourself if you are going through a difficult time with your finances. You might still be reeling from the effects of the recent health crisis. It quickly transitioned into a global pandemic impacting the livelihood of people and the economy of all countries worldwide.
You could be going through a different situation in your life right now. Personal problems, business challenges, or even conflicts in the office. All these could ripple into your finances and you might start to scrutinize every little aspect of it. And in these situations, your debt accounts usually stick out like a sore thumb.
At this point, you might begin to ask yourself if your debt means trouble and if it is high time to focus on them. You realize that a good portion of your income just goes to debt payment and you want to change it. But is it all that bad? Do debt payments do nothing but put you in a big financial hole you cannot climb out of?
To help you understand and process these questions, it helps to look into a few things about your debt. These can give you a better picture of how to manage your debt accounts.
Types of debt
You might have different types of debt and each of them would serve a different purpose. Here are some of the most common ones could have:
- Credit card debt – This is one of the common types of debt for most Americans. There is also a good chance that it has one of the highest interest rates across all your payments.
- Car loan – It is not easy paying for a car in full with cash especially if you are getting a new one. Getting a car loan can help you buy a car in installments.
- Mortgage loan – Buying a house is one of the biggest decisions you will ever make in your life. But this is possible with a mortgage loan where a lender puts a lien on the property while you make monthly payments.
- Student loan – The cost of attendance for college and even post-graduate studies is no joke. This is why a lot of students and their families take out student loans to pay for tuition and repay it once they graduate.
- Payday loan / Personal loan – A lot of people had to rely on payday loans during the pandemic especially the ones who did not have any emergency funds to dip into. It was pretty easy to take out a payday loan, the hard part was the repayment because it carried huge interest and fees.
Reason for debt
Another thing to look into, if you want to understand, is if debt means trouble for you and if your finances are the reason why you take out loans in the first place. Oftentimes, this normally boils down to needs and wants and how they all relate to your long term goals. If the loan you are taking out helps you stick to your goals then there is a good chance that you are making the right decision.
Take a car loan for example – why do you need to buy a new car? Are you doing it because your neighbor just pulled up with a brand-new vehicle on their driveway? You see them with a new car and you suddenly feel the urge to have a new one as well. If this is the case, you are just trying to keep up with the people around you and it might cost you more than what you can afford.
But if you need a new car for a business you are setting up or for work, then it could work in your favor. Since the car loan payment will help you bring in more income every month. In turn, this can bring you closer to your goals of growing your business, saving for a house, or even fast-tracking your retirement goals.
Now that you have this information, the next thing you might want to do is look at the details of your debt payments. These can help you further understand and form your conclusion if debt means trouble for your finances.
Secured or unsecured loan?
You need to take a look at the pros and cons of each. This will help you understand each type better. As a result, it will give you a better grasp of your debt obligations and how each one of them impacts your overall financial situation. But don’t worry, the difference between secured and unsecured loans is pretty simple.
Secured loans normally have an asset tied to the agreement as explained by CNBC. A prime example would be a mortgage loan or a car loan. This means that your lender has a lien on that asset. This acts as a security on a loan and they can get possession of it if you default on payments. The opposite applies to an unsecured loan where you borrow money without any collateral.
Because of the nature of the agreement, secured loans tend to have lower interest rates since your lender can get the collateral as payment. Unsecured loans have a much higher interest rate to offset the risk your lender is taking on as they lend you money. The difference between the two will help you determine how you perceive your debt accounts.
The interest rate on the loan?
This is another important detail you have to keep an eye out for when it comes to your debt obligations, especially with the loans you have. The interest rate varies from one account to the other. Even if you have multiple lenders for the same type of loan, you could be looking at various rates of interest being applied to your payments.
But the general rule is that unsecured loans usually have higher interest rates. This is because the lender is more at risk in case you default on your payments. On the contrary, secured loans tend to have lower interest rates. This is for the same reason that your lender can hold on to collateral. In case you default, they can simply take possession of that collateral to recoup their losses.
The higher the interest rate, the more challenging it will be to pay it off. This is true especially if you choose to settle for the minimum amount every month. Paying more than the minimum will help you pay the account faster and even save you money. Rather than paying huge interest throughout the life of the loan, you pay it off early and save money.
In conclusion – is it true that debt means trouble for your finances?
The short answer to this is no, debt does not always spell trouble for you and your finances. There are times when it can bring you closer to your goals. If you are smart with the types of debt you take, they become valuable financial tools for the life you want to have.